Chapter 6

Business Strategy: Differentiation, Cost Leadership,

and Blue Oceans
 The AFI Strategy Framework

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 Chapter 6 Outline (1 of 2)

6.1 Business-Level Strategy: How to Compete for Advantage

– Strategic Position
– Generic Business Strategies
6.2 Differentiation Strategy: Understanding Value Drivers
– Product Features
– Customer Service
– Complements
6.3 Cost-Leadership Strategy: Understanding Cost Drivers
– Cost of Input Factors
– Economies of Scale
– Learning Curve
– Experience Curve
©McGraw-Hill Education.
 Chapter 6 Outline (2 of 2)

6.4 Business-Level Strategy and the Five Forces:

Benefits and Risks
– Differentiation Strategy: Benefits and Risks
– Cost-Leadership Strategy: Benefits and Risks
6.5 Blue Ocean Strategy: Combining Differentiation
and Cost Leadership
– Value Innovation
– Blue Ocean Strategy Gone Bad: “Stuck in the Middle”
6.6 Implications for the Strategist

©McGraw-Hill Education.
 Learning Objectives

LO 6-1 Define business-level strategy and describe how it determines a

firm’s strategic position.
LO 6-2 Examine the relationship between value drivers and differentiation
strategy.
LO 6-3 Examine the relationship between cost drivers and the cost-
leadership strategy.
LO 6-4 Assess the benefits and risks of differentiation and cost-leadership
strategies vis-à-vis the five forces that shape competition.
LO 6-5 Evaluate value and cost drivers that may allow a firm to pursue a
blue ocean strategy.
LO 6-6 Assess the risks of a blue ocean strategy, and explain why it is
difficult to succeed at value innovation.

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 Business-Level Strategy:
How to Compete for Advantage

©McGraw-Hill Education.
 What Is Business Level Strategy?

• Goal-directed actions managers take

– To achieve competitive advantage
– In a single product market
• “How will we compete to gain & sustain competitive
advantage?”
– Who: which customer segments will we serve?
– What: customer needs, wishes, and desires will we satisfy?
– Why: do we want to satisfy them?
– How: will we satisfy our customers’ needs?

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 Exhibit 6.1 Industry and Firm Effects Jointly
Determine Competitive Advantage

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 Strategic Trade-Offs

• Choices between a cost or value position

• There is tension between:
– Value creation and
– Pressure to keep cost in check
• Purpose of trade offs are to maximize the firm’s:
– Economic value creation
– Profit margin

©McGraw-Hill Education.
 Generic Business Strategies

• Differentiation
– Seeks to create higher value than competitors
– Offers products or services with unique features
– Keeps the firm’s cost structure as low as possible
– Charges higher prices
• Cost Leadership
– Seeks to create similar value than competitors
– Products or services delivered at lower cost
– Charges lower prices

©McGraw-Hill Education.
 Focused Business Strategies

• Focus on a narrower competitive scope

• Types:
– Focused Differentiation
• Ex: Mont Blanc: exquisite pens at several hundred dollars

– Focused Cost Leadership

• Ex: BIC: disposable pens and lighters at low cost

• Scope of competition:
– The size (narrow or broad) of the market in which a firm
chooses to compete

©McGraw-Hill Education.
 Exhibit 6.2 Strategic Position and Competitive Scope:
Generic Business Strategies

SOURCE: Adapted from M.E.

Porter (1980), Competitive
Strategy. Techniques for
Analyzing Industries and
Competitors (New York: Free
Press).

©McGraw-Hill Education.
 Differentiation Strategy:
Understanding Value Drivers

©McGraw-Hill Education.
 Differentiation Strategy

• Unique features that increase value of goods and

services
• Consumers are willing to pay a higher price.
• The focus of competition:
– Unique product features
– Service
– New product launches
– Marketing and promotion
• Competitive advantage achieved when:
– Value – Cost > competitors

©McGraw-Hill Education.
 Exhibit 6.3 Achieving Competitive Advantage with a
Differentiation Strategy

Competitive advantage achieved as long as economic value

created (V - C) is greater than competitors

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 Three Drivers That Can Increase Value

• Product features
• Customer service
• Complements

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 Product Features

• Increases perceived value

• Turns commodity products into differentiated
products
• Strong R&D capabilities are often needed

©McGraw-Hill Education.
 Customer Service

• Increases perceived value

• Example: Zappo’s
– Offers free shipping both ways
– They do not outsource customer service
– Don’t use pre-determined scripts for service
• Example: Trader Joe’s:
– Stores stock local products as requested by the community

©McGraw-Hill Education.
 Complements

• Increases perceived value

• Consumed in tandem
• Example: AT&T U-verse
– Bundles Internet access, phone, and TV services
• Example: DVR
– Enables pause & recording of TV shows

©McGraw-Hill Education.
 Differentiation Strategies:

• Add value to products and services

• Are responsive to customer preferences
• Can increase costs
– Additional R&D is needed
– Innovation is needed
– But customers are willing to pay a premium

©McGraw-Hill Education.
 Cost-Leadership Strategy:
Understanding Cost Drivers

©McGraw-Hill Education.
 Cost Leadership Strategy

• Goal:
– Reduce the firm’s cost below its competitors
– Offer adequate value
• Resources are focused on:
– Reducing cost
• To manufacture a product
• To offer a service

– Reducing prices for customers

– Optimizing the value chain to achieve low-cost

©McGraw-Hill Education.
 Exhibit 6.4 Achieving Competitive Advantage with
a Cost Leadership Strategy

Firms that keep their costs low while offering acceptable value
gain a competitive advantage

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 Four Cost Drivers That Help Keep Costs Low

• Cost of input factors

• Economies of scale
• Learning-curve effects
• Experience-curve effects

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 Cost of Input Factors

• Input factors such as:

– Raw materials
– Capital
– Labor
– IT services
• Example: the airline industry
– Access to cheaper fuel
– Interest-free government loans
– Access to nighttime takeoffs and landings

©McGraw-Hill Education.
 Exhibit 6.5 Economies of Scale

Decreases in per unit costs as output increases

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 Economies of Scale Allows Firms To:

• Spread fixed costs over a larger output

– Ex: Microsoft spent $25 billion on R&D for Windows 7
before a single copy was sold
• Employ specialized systems and equipment
– Ex: Demand for Tesla’s Model S sedan allowed it to employ
cutting-edge robotics
• Take advantage of certain physical properties
– Ex: Big box stores can stock more merchandise and handle
inventory efficiently

©McGraw-Hill Education.
 Learning Curve Effects

• Learning drives down costs.

– It takes less time to produce the same output.
– We learn how to be more efficient.
• People learn from cumulative experience:
– Writing computer code
– Developing new medicines
– Building submarines
• First noted during WWII:
– When production doubled, per-unit cost dropped 20%.
©McGraw-Hill Education.
 Exhibit 6.6 Learning Curve and Experience Curve Effects

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 Strategy Highlight 6.1 (1 of 2)

Dr. Shetty: “The Henry Ford of Heart Surgery”

•Trained in London
•Conducted open-heart surgery on Mother Teresa
•Goal: drive down costs through process innovation
•Applies learning curves to his work
– They work six days per week
– Their skills improve quicker than their U.S. counterparts

©McGraw-Hill Education.
 Strategy Highlight 6.1 (2 of 2)

Dr. Shetty: “The Henry Ford of Heart Surgery”

•Achieves economies of scale
– Fixed costs spread over larger volume
– They can employ more specialized equipment
– They share common services with the cancer clinic
•Data suggests
– Higher volume does not compromise quality

©McGraw-Hill Education.
 Experience Curve Effects

• When technology is changed while output is

constant
• Examples:
– A new production process
– Implementing lean manufacturing

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 Cost Leadership Strategies

• Appeal to the bargain-conscious buyer

• Offer lower prices than competitors
• Attract an increased volume of sales
• Can be profitable over a long period of time

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 Business-Level Strategy and the
Five Forces: Benefits and Risks

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Exhibit 6.7 Benefits & Risks of Competitive Positioning

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 The Success of Business Strategy Relies On

• How well the strategy:

– Leverages the firm’s internal strengths
– Mitigates its weaknesses
• How well it helps the firm:
– Exploit external opportunities
– Avoid external threats

©McGraw-Hill Education.
 Blue Ocean Strategy: Combining Differentiation
and Cost Leadership

©McGraw-Hill Education.
 What Is Blue Ocean Strategy?

• Successfully combining differentiation and cost-

leadership activities
• Uses value innovation to reconcile trade-offs
• The metaphor of blue ocean means:
– Untapped market space
– The creation of additional demand
– The opportunity for highly profitable growth

©McGraw-Hill Education.
 Example of a Successful Blue Ocean Strategy: Trader Joe’s

• A regional grocer
• Offers high value and health conscious foods
• Offers much lower costs than Whole Foods

©McGraw-Hill Education.
 Exhibit 6.8 Value Innovation

Accomplished through the simultaneously pursuing

differentiation (V ↑) and low cost (C ↓)

SOURCE: Adapted from C.W.

Kim and R. Mauborgne (2005),
Blue Ocean Strategy: How to
Create Uncontested Market
Space and Make Competition
Irrelevant (Boston, MA: Harvard
Business School Publishing).

©McGraw-Hill Education.
 To Achieve Successful Value Innovation, Answer These
Questions

• Lowering costs
– Eliminate: Which of the factors that the industry takes for
granted should be eliminated?
– Reduce: Which of the factors should be reduced well
below the industry’s standard?
• Increasing perceived consumer benefits
– Raise: Which of the factors should be raised well above the
industry’s standard?
– Create: Which factors should be created that the industry
has never offered?

©McGraw-Hill Education.
 Blue Ocean: How IKEA Did It

• Eliminate
– Sales people
– After sales service
• Reduce
– Warranties
• Raise
– Offers tens of thousands of home furnishing items
• Create
– New way to shop for furniture
©McGraw-Hill Education.
 Exhibit 6.9 A Blue Ocean Strategy is Difficult to
Implement

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 Strategy Highlight 6.2 (1 of 2)

How JCPenney Sailed Deeper into the Red Ocean

•Ron Johnson hired as CEO
– He previously led Apple’s retail stores
•Attempted a strategic change:
– From cost leadership
– To a blue ocean strategy
•Many changes implemented:
– More in-store boutiques
– Removed clearance racks and coupons
©McGraw-Hill Education.
 Strategy Highlight 6.2 (2 of 2)

How JCPenney Sailed Deeper into the Red Ocean

• Results:
– Sales dropped by 25%.
– Their stock was dropped from the S&P 500 index.
– Johnson was fired.
– His predecessor came out of retirement to step in.
– Experienced a sustained competitive disadvantage

©McGraw-Hill Education.
 The Value Curve and the Strategy Canvas

• The Value Curve

– Horizontal connection points
– Located on the strategy canvas
– Helps strategists determine courses of action
• The Strategy Canvas
– Graphical depiction of a company’s performance
– Relative to its competitors
– Viewed across the industry’s key success factors

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 Exhibit 6.10 Example of a Strategy Canvas

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 Implications for the Strategist

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 Only a Handful of Strategic Options Are Available

• Low cost or differentiation

• Broad or narrow
• Blue ocean
• So managers must…
– Understand firm and industry effects
– Fine-tune strategy formulation and execution

©McGraw-Hill Education.
 Successful Blue Ocean Strategy

• Changes the competitive landscape

• Opens up new areas of competition
• Requires the firm to:
– Reconcile trade-offs
• Increasing value
• Lowering production costs
– Pursue both business strategies simultaneously
• Example: Toyota
– Introduced lean manufacturing
– Delivered higher quality cars at lower cost

©McGraw-Hill Education.
 Chapter 6 Summary

©McGraw-Hill Education.
 Take Away Concepts (1 of 6)

LO 6-1 Define business-level strategy and describe how it determines a

firm’s strategic position.
•Business-level strategy determines a firm’s strategic position in its quest for
competitive advantage when competing in a single industry or product
market.
•Strategic positioning requires that managers address strategic trade-offs that
arise between value and cost, because higher value tends to go along with
higher cost.
•Differentiation and cost leadership are distinct strategic positions.
•Besides selecting an appropriate strategic position, managers must also
define the scope of competition—whether to pursue a specific market niche
or go after the broader market.

©McGraw-Hill Education.
 Take Away Concepts (2 of 6)

LO 6-2 Examine the relationship between value drivers and differentiation

strategy.
•The goal of a differentiation strategy is to increase the perceived value of
goods and services so that customers will pay a higher price for additional
features.
•In a differentiation strategy, the focus of competition is on value-enhancing
attributes and features, while controlling costs.
•Some of the unique value drivers managers can manipulate are product
features, customer service, customization, and complements.
•Value drivers contribute to competitive advantage only if their increase in
value creation (∆V) exceeds the increase in costs, that is: (∆V) > (∆C).

©McGraw-Hill Education.
 Take Away Concepts (3 of 6)

LO 6-3 Examine the relationship between cost drivers and the cost-
leadership strategy.
•The goal of a cost-leadership strategy is to reduce the firm’s cost below that
of its competitors.
•In a cost-leadership strategy, the focus of competition is achieving the lowest
possible cost position, which allows the firm to offer a lower price than
competitors while maintaining acceptable value.
•Some of the unique cost drivers that managers can manipulate are the cost
of input factors, economies of scale, and learning- and experience-curve
effects.
•No matter how low the price, if there is no acceptable value proposition, the
product or service will not sell.

©McGraw-Hill Education.
 Take Away Concepts (4 of 6)

LO 6-4 Assess the benefits and risks of differentiation and cost-leadership

business strategies vis-à-vis the five forces that shape competition.
• The five forces model helps managers use generic business strategies to
protect themselves against the industry forces that drive down profitability.
• Differentiation and cost-leadership strategies allow firms to carve out
strong strategic positions, not only to protect themselves against the five
forces, but also to benefit from them in their quest for competitive
advantage.
• Exhibit 6.7 details the benefits and risks of each business strategy.

©McGraw-Hill Education.
 Take Away Concepts (5 of 6)

LO 6-5 Evaluate value and cost drivers that may allow a firm to pursue a
blue ocean strategy.
•To address the trade-offs between differentiation and cost leadership at the business
level, managers must employ value innovation, a process that will lead them to align
the proposed business strategy with total perceived consumer benefits, price and
cost.
•Lowering a firm’s costs is primarily achieved by eliminating and reducing the taken-
for-granted factors on which the firm’s industry rivals compete.
•Increasing perceived buyer value is primarily achieved by raising existing key success
factors and by creating new elements that the industry has not yet offered.
•Managers will track their opportunities and risks for lowering a firm’s costs and
increasing perceived value vis-à-vis their competitors by use of a strategy canvas,
which plots industry factors among competitors (see Exhibit 6.10).

©McGraw-Hill Education.
 Take Away Concepts (6 of 6)

LO 6-6 Assess the risks of a blue ocean strategy, and explain why it is
difficult to succeed at value innovation.
•A successful blue ocean strategy requires that trade-offs between
differentiation and low cost be reconciled.
•A blue ocean strategy often is difficult because the two distinct strategic
positions require internal value chain activities that are fundamentally
different from one another.
•When firms fail to resolve strategic trade-offs between differentiation and
cost, they end up being “stuck in the middle.” They then succeed at neither
business strategy, leading to a competitive disadvantage.

©McGraw-Hill Education.
 Key Terms
• Blue ocean strategy • Focused differentiation
strategy
• Business-level strategy
• Minimum efficient scale
• Cost-leadership strategy
(MES)
• Differentiation strategy
• Scope of competition
• Diseconomies of scale
• Strategic trade-offs
• Economies of scale
• Strategy canvas
• Economies of scope
• Value curve
• Focused cost-leadership
• Value innovation
strategy

©McGraw-Hill Education.
 Chapter 6 Cases & Exercises

©McGraw-Hill Education.
 Chapter Case 6: Consider This… (1 of 2)

• JetBlue’s early competitive advantage:

– Drove up customer perceived value
– Simultaneously lowered costs
– Result: created a blue ocean
• JetBlue was unable to sustain this position.
• New CEO implemented changes
– Charging for bags, which previously were free
– Removed additional legroom

©McGraw-Hill Education.
 Chapter Case 6: Consider This… (2 of 2)

• Why was JetBlue unable to sustain a blue ocean

strategy?
• JetBlue claims to not be in the commodity but in the
services business:
– What strategic position is this?
– Does the CEO’s changes align with this positioning?
• Why is JetBlue experiencing a competitive
advantage? What recommendations would you
offer?

©McGraw-Hill Education.
 My Strategy Exercise Low-Cost and Differentiated
Workplaces (1 of 2)

• Firm strategy impacts

– The employee’s experience
– The firm’s work environment and culture
• Differentiated strategy companies
– Focus on product features and customer service
– Examples: Nordstrom, Whole Foods, and Wegmans
– Many listed in Fortune’s “100 Best Places to Work”

©McGraw-Hill Education.
 My Strategy Exercise Low-Cost and Differentiated
Workplaces (1 of 2)

• Cost leadership strategy companies

– Focus on remaining the low cost leader
– Examples: Amazon and Walmart
– Offers many opportunities to learn
• In which type of environment would you thrive?
• What aspects of success are you seeking in your
professional career?
• What trade-offs would you NOT be willing to make?

©McGraw-Hill Education.
 Small Group Exercise #1

• Ryanair based in Dublin, Ireland

• Airline ticket: $20
– Profits made through fees & surcharges
• The “Amazon.com of travel in Europe”
• How would you compete against Ryanair?
• What are their similarities & differences with
JetBlue?

©McGraw-Hill Education.
 Small Group Exercise #2

• Note the table in your text of prominent firms

• Select one of the five business-level strategies:
– Broad cost leadership
– Focused cost leadership
– Broad differentiation
– Focused differentiation
– Value innovation
• Add that strategy to the table, and explain your
choices

©McGraw-Hill Education.
 End of Chapter 6

©McGraw-Hill Education.
 Strategy Smart Videos

©McGraw-Hill Education.
 Strategy Smart Videos (1 of 6)

• Renée Mauborgne, co-author of Blue Ocean Strategy

• How to create new markets and leave the
competition behind
• Link:
– https://www.youtube.com/watch?v=clp-IMpuwaQ
• 6:01 Minutes

©McGraw-Hill Education.
 Strategy Smart Videos (2 of 6)

• Dr. Michael Porter

• HBS: Michael Porter on Competitive Strategy
• Part 1: Cost Leadership
• Link:
– http://www.youtube.com/watch?v=c4ZBVp8-9gA
• 1:12:18 Minutes

©McGraw-Hill Education.
 Strategy Smart Videos (3 of 6)

• Dr. Michael Porter

• HBS: Michael Porter on Competitive Strategy
• Part 2: Differentiation
• Link:
– https://www.youtube.com/watch?v=znzCtevIRLQ
• 1:17:57 Minutes

©McGraw-Hill Education.
 Strategy Smart Videos (4 of 6)

• Dr. David Kryscynski

• Generic Strategies Mini-Lecture
• Link:
– https://www.youtube.com/watch?v=V14kuqYEsxE
• 4:47 Minutes

©McGraw-Hill Education.
 Strategy Smart Videos (5 of 6)

• Jenny Rosenstrac: blogger, author and working mom

of two
• How to value shop at Whole Foods Market
– Whole Foods Market, a differentiator, typically claims
higher prices. This video highlights one food blogger telling
customers how to save money and find deals.
• Link:
– https://www.youtube.com/watch?v=3o2-s6Q9sNo
• 3:23 Minutes

©McGraw-Hill Education.
 Strategy Smart Videos (6 of 6)

• Strategy Canvas example

• American Airlines vs. Southwest Airlines
• Links:
– https://www.youtube.com/watch?v=AGREE7D8vvU
• 2:25 Minutes

©McGraw-Hill Education.
 Chapter Case 6

©McGraw-Hill Education.
 Chapter Case 6: JetBlue (1 of 2)

• JetBlue founded in 1998

– Initial strategy: low-cost airfare, great service & amenities

– Copied / improved on Southwest’s business model

– Flew longer distances / transported more passengers
• This drove down costs
• Attempted to drive up its perceived value
– Leather seats, free movie programming
– Friendly, attentive service
– Private suites, personal screens, wifi
– Remote employees take reservations

©McGraw-Hill Education.
 Chapter Case 6: JetBlue (2 of 2)

• Several incidents damaged customer service record:

– Passengers kept on the tarmac for 9 hours during a
snowstorm
– Flight attendant insulted passengers before deploying the
emergency escape chute
– Issues of pilot mental health
• JetBlue is now struggling
– Sustained competitive disadvantage since 2007

©McGraw-Hill Education.
 Appendix 1 The AFI Strategy Framework
The important inside circle is titled "Gaining and Sustaining a Competitive Advantage" that is at the very center of the image, with
five different circles on the outside of it. Arrows go back and forth from the center circle to each of the five outer circles. The five
outer circles are labeled: (1) Getting Started, (2) External and Internal Analysis, (3) Formulation: Business Strategy, (4)
Formulation, Corporate Strategy, and (5) Implementation.

Each of these outer five circles have a brief description beside them to explain what the circle means:

Under the first outer circle titled "Getting Started", it says: Part 1, Strategy Analysis, "What is Strategy (Chapter 1)" and "Strategic
Leadership: Managing the Strategy Process (Chapter 2)".

Under the second outer circle titled "External and Internal Analysis", it says: Part 1, Strategy Analysis, "External Analysis: Industry
Structure, Competitive Forces and Strategic Groups (Chapter 3)", "Internal Analysis: Resources, Capabilities and Core
Competencies (Chapter 4)", and "Competitive Advantage, Firm Performance, and Business Models (Chapter 5)".

Under the third outer circle titled "Formulation: Business Strategy", it says: Part 2, Strategy Formulation, "Business Strategy:
Differentiation, Cost Leadership and Integration (Chapter 6)" and "Business Strategy, Innovation and Entrepreneurship (Chapter
7)".

Under the fourth outer circle titled "Formulation: Corporate Strategy", it says: Part 2, Strategy Formulation, "Corporate Strategy:
Vertical Integration and Diversification (Chapter 8)", "Corporate Strategy: Strategic Alliances, Mergers and Acquisitions (Chapter
9)", and "Global Strategy: Competing Around the World (Chapter 10)".

Under the fifth outer circle titled "Implementation", it says: Part 3, Strategy Implementation, "Organizational Design: Structure,
Culture and Control (Chapter 11)", and "Corporate Governance and Business Ethics (Chapter 12)".

Return to slide

©McGraw-Hill Education.
 Appendix 2 Exhibit 6.1 Industry and Firm Effects Jointly
Determine Competitive Advantage

This image shows a process map, beginning with Industry Effects and Firm
Effects, which are both linked with a two-direction arrow. Industry effects
points to another box titled "Industry Attractiveness" (Five Forces Model, and
Complements), which points to a box titled "Within Industry" (Strategic
Groups). Firm Effects points to two boxes, one titled "Value Position" (relative
to competitors) and the other is titled "Cost Position" (relative to
competitors). Both of these boxes point to a box titled "Business Strategy"
(Cost Leadership, Differentiation, Value Innovation). Both the "Within
Industry" box from the Industry Effects side and the "Business Strategy" box
from the Firm Effects side point to a final box titled "Competitive Advantage."

Return to slide

©McGraw-Hill Education.
 Appendix 3 Exhibit 6.3 Achieving Competitive Advantage
with a Differentiation Strategy

On the left, at a disadvantage, is Firm A that offers the lowest amount of value. On the right are
two companies that are at an advantage. Both firm B and firm C have higher value than Firm A,
however firm B extracts higher value because it has lower costs.
Firm A in this image produces a generic commodity. Firm B and Firm C represent two efforts at
differentiation. Firm B not only offers greater value than Firm A, but also maintains cost parity,
meaning it has the same costs as Firm A. However, even if a firm fails to achieve cost parity
(which is often the case because higher value creation tends to go along with higher costs in
terms of higher-quality raw materials, research and development, employee training to provide
superior customer service, and so on), it can still gain a competitive advantage if its economic
value creation exceeds that of its competitors. Firm C represents just such a competitive
advantage. For the approach shown either in Firm B or Firm C, economic value creation, (V - C)B
or (V – C)C, is greater than that of Firm A (V - C)A. Either Firm B or C, therefore, achieves a
competitive advantage because it has a higher value gap over Firm A [(V - C)B > (V - C)A, or (V –
C)C > (V – C)A], which allows it to charge a premium price, reflecting its higher value creation. To
complete the relative comparison, although both companies pursue a differentiation strategy,
Firm B also has a competitive advantage over Firm C because although both offer identical value,
Firm B has lower cost, thus (V - C)B > (V - C)C.

Return to slide

©McGraw-Hill Education.
 Appendix 4 Exhibit 6.4 Achieving Competitive Advantage
with a Cost Leadership Strategy

On the left, at a disadvantage, is Firm A that offers higher cost and lower value. On the
right are two companies that are at an advantage. Both firm B and firm C have lower
costs than Firm A, however firm B extracts higher value.
In both approaches to cost leadership in this image, Firm B’s economic value creation
is greater than that of Firm A and Firm C. Yet, both firms B and C achieve a competitive
advantage over Firm A. Either one can charge prices similar to its competitors and
benefit from a greater profit margin per unit, or it can charge lower prices than its
competition and gain higher profits from higher volume. Both variations of a cost-
leadership strategy can result in competitive advantage. Although Firm B has a
competitive advantage over both firms A and C, Firm C has a competitive advantage in
comparison to Firm A.

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©McGraw-Hill Education.
 Appendix 5 Exhibit 6.5 Economies of Scale

In the Economies of Scale phase, cost per unit falls as output

increases up to a certain point. A firm whose output is closer to
this point has a cost advantage over other firms with less output.
In this sense, bigger is better. The second part of the curve is the
Minimum Efficient Scale phase. In this phase, returns are
constant and are flat, as further economies of scale cannot be
achieved. In the third phase of the graph, towards the right side,
diseconomies of scale are realized as additional output results in
per unit cost increases.

Return to slide

©McGraw-Hill Education.
 Appendix 6 Exhibit 6.6 Learning Curve
and Experience Curve Effects

In a 90 percent learning curve, per-unit cost drops 10 percent every time

output is doubled. The steeper 80 percent learning curve indicates a 20
percent drop every time output is doubled.
It is important to note that the learning-curve effect is driven by increasing
cumulative output within the existing technology over time. That implies that
the only difference between two points on the same learning curve is the size
of the cumulative output. The underlying technology remains the same. The
speed of learning determines the slope of the learning curve, or how steep
the learning curve is (e.g., 80 percent is steeper than a 90 percent learning
curve, because costs decrease by 20 percent versus a mere 10 percent each
time output doubles).

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©McGraw-Hill Education.
 Appendix 7 Exhibit 6.7 Benefits & Risks of Competitive
Positioning

In particular, the table highlights the benefits and risks of differentiation and cost-leadership business strategies.
Under Cost Leadership, the benefits and risks are as follows:
Threat of Entry: Benefits: protection against entry due to economies of scale. Risks: erosion of margins and replacement
Power of Suppliers: Benefits: protection against increase in input prices, which can be absorbed. Risks: erosion of margins.
Power of Buyers: Benefits: protection against decrease in sales prices, which can be absorbed, Risks: erosion of margins.
Threat of Substitutes: Benefits: protection against substitute products through further lowering of prices. Risks: replacement, especially when
faced with innovation.
Rivalry among existing competitors: Benefits: protection against price wars because lowest-cost firm will win. Risks: focus of competition
shifts to non-price attributes, and lowering costs to drive value creation below acceptable threshold.
Under Differentiation, the benefits and risks are as follows:
Threat of Entry: Benefits: protection against entry due to resources such as a reputation for innovation, quality or customer service. Risks:
erosion of margins and replacement
Power of Suppliers: Benefits: protection against increase in input prices, which can be passed on to customers. Risks: erosion of margins.
Power of Buyers: Benefits: protection against decrease in sales prices, which because well-differentiated products or services are not perfect
imitations. Risks: erosion of margins.
Threat of Substitutes: Benefits: protection against substitute products due to differential appeal. Risks: replacement, especially when faced
with innovation.
Rivalry among existing competitors: Benefits: premium price. Risks: focus of competition shifts to price, increasing differentiation of product
features that do not create value but raise costs, and increasing differentiation to raise costs above acceptable threshold.

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 Appendix 8 Exhibit 6.9 A Blue Ocean Strategy is Difficult to
Implement

This image shows four squares: Cost Leadership (broad scope and focused on
cost), Differentiation (broad scope and focused on differentiation), Focused
Cost Leadership (narrow scope and focused on cost), and Focused
Differentiation (narrow scope and focused on differentiation). In the middle
of this graphic is a square that says "Blue Ocean Strategy vs. Stuck in the
Middle."
This image suggests how a successfully formulated blue ocean strategy based
on value innovation combines both a differentiation and low-cost position. It
also shows the consequence of a blue ocean strategy gone bad—the firm
ends up being stuck in the middle, meaning the firm has neither a clear
differentiation nor a clear cost-leadership profile. Being stuck in the middle
leads to inferior performance and a resulting competitive disadvantage.

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©McGraw-Hill Education.
 Appendix 9 Exhibit 6.10 Example of a Strategy Canvas

On the X axis are the key industry metrics of price, seating class, in-flight
amenities, meals, connections (via hub), lounges, international routes,
customer service, reliability and convenience. On the Y axis are the words
"Low" and "High".
Scoring mostly on the high end of this graph are the Legacy Carriers, who
pursue a differentiation strategy. Scoring mostly on the low end of this graph
are the Low-Cost Airlines who pursue a cost-leadership strategy. In the
middle, is JetBlue, who oscillates from low to high in a number of categories,
indicating a lack of effectiveness in its strategic profile.

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